Outlook 2005: Integrating Cost Control and Revenue Growth

As global growth slackens in 2005, sustainable improvements in real economic value will require a better balance between the cost-control techniques companies honed during the downturn and the top-line growth strategies they developed in the recovery.

Corporate balance sheets for 2004 reflect the absence of clarity in the current recovery and, in many cases, businesses' piecemeal, ad hoc approach to cost control and top-line revenue growth, the twin paths to greater profitability. Corporations that binged on spending at the close of the last decade moved into purge mode during the 2001 recession and 2002 slowdown. In most sectors, companies exhausted their ability to restore profitability through cost reductions in 2003, and they reinstated strategies for top-line growth this year. But revenue improvements will become more difficult in 2005 as global growth slows and upward pressures on costs reappear. The economic forecast for next year includes moderately lower U.S. and global GDP increases, higher interest rates, rising inflation, and lower profit margins. The International Monetary Fund (IMF) has revised its earlier forecasts downward and now puts world output growth at 4.3 percent for 2005, down from an estimated 5 percent for 2004. Sluggish domestic markets in the United States, Europe and Japan and slightly slower growth in the developing nations will coexist with higher commodity prices and financing costs. The second half of 2004 foreshadowed the lower-growth terrain that lies ahead and outlined the new terms for success in a distinctly chillier economic environment.

The IMF expects U.S. GDP to grow by 3.5 percent in 2005 -- down sharply from its earlier forecast of 4.3 percent -- with inflation at 3 percent, driven largely by higher commodity prices. The Federal Reserve and most of the other G7 central banks have already signaled that they will likely increase interest rates over the next 12 months.

For U.S.-based companies, sustainable corporate growth in this phase of the cycle will require an integrated approach to cost control and top-line objectives. The new economic parameters for 2005 will also require rapid globalization in order to expand cost advantages and exploit new markets.

Integrating Objectives

The new, more difficult conditions that surfaced in the second quarter of 2004 and will continue through 2005 are distinctly visible in the auto parts industry, which is caught between suppliers facing higher costs from escalating steel and oil prices and automakers mired in slowing sales. BorgWarner Inc., a Chicago-based provider of components and systems for vehicle power train applications with $3.5 billion in annual revenues, will navigate these conditions more easily than will most of its peers. BorgWarner is a stellar example of an organization that has integrated the dual objectives of cost control and revenue growth while pursuing globalization to build economic value on a sustainable basis. Moreover, it has achieved those goals in a highly cyclical, low-growth industry.

"To be successful, our top-line growth must be coupled with an intense focus on costs," says Robin J. Adams, BorgWarner's executive vice president, CFO and chief administrative officer. "We know it's our job to manage through the ups and downs of our business. We are a product-technology-driven company, but we also have a disciplined approach to achieving cost efficiencies in our manufacturing operations. As an auto supplier, cost reduction is simply a way of life."

BorgWarner manufactures and sells its technologically innovative products on a global basis, and it concentrates on the fastest-growing segments of the automotive market to drive revenues and profitable growth. Those strategies have enabled the company to consistently meet its long-range growth targets of 8 percent to 11 percent for sales and 12 percent to 16 percent for profits.

Integrating cost-control and revenue-growth objectives calls for a long-term strategy. BorgWarner increased its R&D spending and reduced its debt every year through the 2001-2002 downturn and into the 2003-2004 recovery. "We've seen industry downturns as well as upturns many times before," Adams points out. "Because of that, we run our business with a longer-term perspective. As we make decisions on new investments, we evaluate them under a number of potential volume alternatives, ensuring that we can provide an adequate financial return even at lower industry production levels.

"Also, during a downturn, we make sure we don't cut areas that are critical to our long-term future, such as R&D and capital spending," Adams notes. "That enables us to grow our business and improve profitability more quickly when the economy starts to strengthen again."

Maximizing Globalization

In most industries, globalization is critical to both cost control and revenue growth, and it will become the primary corporate imperative for 2005. The drive to uncover efficiencies continues to fuel offshore outsourcing, foreign direct investment and global materials sourcing as essential elements in a comprehensive cost-control strategy. And the search for greater top-line growth means that companies must continuously explore new markets.

BorgWarner produces its engines and drivetrains in 43 locations in 14 countries, including Mexico, Hungary, China, India, South Korea and Japan. The company has developed a flexible global production system that enables it, for example, to use available European capacity to manufacture its drive systems for the new Kia Sorento and then export those products.

Globalization has played a central role in BorgWarner's quest for a diversified customer base that can protect it from cyclical economic swings and rapidly changing market share among the automakers. The company pulls more than half of its revenues from outside the United States.

"In the past 10 years we've increased the diversification of our customer base to mirror the changing dynamics and demands of the global automotive marketplace," Adams reports. This strategy has enabled BorgWarner to escape the precarious position of other U.S.-based auto suppliers who remain tied to the Big Three and rise or fall with them. The company's key non-U.S. customers include Hyundai, Toyota, Honda, Renault and Volkswagen.

BorgWarner's approach to new markets differs from the regional strategy that many companies pursue. "We focus our growth not so much on geographic regions but on where the greatest demand for new product technology is around the world," Adams explains. "Right now, a good portion of that happens to be outside of the U.S., particularly in Europe. Other areas of growing demand are in China, India and other Asian nations."

High-Tech Outreach

Like the auto industry, the high-tech sector continues to suffer in this uneven recovery, and it faces the prospect of more difficult conditions in 2005. EDS, the Plano, Texas-based business and technology applications and services provider, is accelerating its globalization efforts in order to increase efficiencies and revive profitability. In April, the company opened a new business process outsourcing [BPO] service center in Budapest, Hungary. The facility supports all major European languages. By the close of this year, EDS expects to have 1,000 employees in Hungary.

"We're investing in the build-out of our strategic technology platform, focusing on fast-growing areas such as business process outsourcing and transformation," says EDS executive vice president and CFO Robert H. Swan. "Our goal is to make information technology a strategic advantage for our clients, enabling them to drive speed, agility and leverage into their enterprises."

Increased globalization is central to EDS's cost-control program and the growth of its BPO division. The company currently has 42 offshore locations with a total of 9,200 full-time employees. It expects to have 20,000 workers in offshore locations by the end of 2005. Its overall workforce will decline by an estimated 20,000 employees in the same period.

EDS is targeting cost reductions of $1 billion for 2004 and another $2 billion over the next two years. Earlier this year, it moved the help desk for its own employees to India, cutting its costs by almost half.

Another high-tech company that's looking beyond U.S. borders to secure its future growth is Mountain View, Calif.-based VeriSign Inc., an Internet, security and telecommunications service provider with $1 billion in annual revenues and subsidiaries in Japan, Australia, Latin America and Europe. At the end of a tough year in 2003, the company divested a nonstrategic business with subpar financial performance that masked VeriSign's underlying core growth. It also refocused its medium- and long-term growth strategies on global expansion. In June of this year, VeriSign acquired Jamba! AG, Europe's largest wireless content and services provider.

"We look for increased international penetration as well as the introduction of new services into our markets," says Dana Evan, VeriSign's executive vice president and CFO. "On the international front, our Jamba! acquisition will not only fuel our entrance into the rich mobile content space, but we expect it to be a major force in growing our international business. In Europe, the Jamba! business has experienced a hyper-growth phase for wireless content download. We plan on leveraging that success to drive selling opportunities for our other services and business units, as well as rolling out the wireless content platform in the U.S."

New Geography

With costs rising and domestic markets slowing, continued foreign expansion will be the centerpiece of corporate growth strategies for most U.S.-based organizations in 2005. But globalization is no longer an exclusively advanced-nation phenomenon. Foreign direct investment outflows from developing countries have grown faster in the past 15 years than have those from developed nations. What's more, they are accelerating rapidly, according to a September 2004 report from the United Nations Conference on Trade and Development. CFOs at companies based in developing countries increasingly realize that they need geographically diverse operations to achieve the ongoing cost efficiencies and high revenue growth necessary for international competitiveness.

Not far from the new EDS service center in Budapest is an offshore development center operated by Tata Consultancy Services (TCS), the Bombay, India-based IT services provider. With 28,000 consultants in 32 countries and more than $1 billion in annual sales, TCS is expanding rapidly into developed and developing countries. In April, the company opened a new center in Detroit to serve its automotive industry clients, and in September it launched a new media and entertainment IT lab in Burbank, Calif., to serve five major Hollywood studios. TCS draws 65 percent of its revenues from the United States.

The company's expansion outside of India has been rapid and decisive. "We see different kinds of growth patterns in different regions throughout the world," says S. Mahalingam, CFO. "Recent years have seen the opening up of newer territories such as China and [Latin] America. Our expansion strategy is a solutions-based approach that is sometimes targeted at specific industries. For example, in the U.S. our financial solutions and services are focused around the Boston area. The focus on solutions and services we can deliver to the automotive industry -- and customers' need for servicing and delivery -- made us decide on Detroit."

TCS also runs development centers in a number of developing countries. "TCS has a constantly growing global footprint," Mahalingam reports. "Each global delivery center, whether in Huangzhou or Budapest, incorporates different delivery patterns based on language and diversity. In Montevideo, Uruguay, our emphasis is on serving the Spanish-speaking markets, while in Budapest we address European diversity and proximity. In Huangzhou, the starting point was servicing our global multinational customers who were present in China, but now domestic market compulsions drive growth as well."

Strategic CFOs

In 2005, CFOs will need to drive sophisticated strategies that integrate cost-cutting and top-line growth. "By now most companies have taken as much cost out of their systems as they can; the well is going dry," notes Ed Boswell, CEO of The Forum Corp., a learning and leadership development consultancy in Boston. "Also, shareholders reward sustainable growth, and growing profits through cost-cutting is not sustainable. Eventually, you reach an end to effective cost-cutting strategies and need to demonstrate that you can grow revenues and earnings."

Finance executives sit at the center of new strategy development. "At BorgWarner, growth objectives and growth strategy are driven by the company's strategy board, which includes officers from all functions of the organization," Adams reports. "My role as CFO is to evaluate the growth strategy and growth objectives from our investors' perspective; ensure that the right resources are in place to achieve these objectives; and maintain a disciplined focus on managing investments and our cost structure so that our growth strategy results not only in time-line growth, but -- more importantly -- in growth in economic value."

VeriSign's Evan also commands a central role. "We take a very focused approach to strategic and operational planning," she says. "The CEO and I work with the executive management team to drive the overall long-term strategy and underlying goals and objectives. We then work with the business units to create operating plans to execute against these strategies and to meet or exceed the goals. During this process, my team works to align the strategies with the operating plans, ensuring that investments and resource allocations are made to best position the company for future growth and profitability."

For even the most astute CFOs, the business environment will be less conducive to growth in 2005 than it has been for the past two years. Finance executives in developing countries increasingly face fallout from economic and fiscal issues in the United States, including what Mahalingam describes as problems "created by increasing protectionism." For U.S.-based companies, interest rates and inflation will rise more quickly than they will for most of their European and Asian competitors. Proactive CFOs recognize that a U.S.-centric approach only aggravates those disadvantages, and they are turning to global flexibility as the solution.

Leadership Skills for Sustainable Growth

To succeed within the new higher-cost, slower-growth economic parameters of 2005, companies will need to develop sustainable growth strategies that integrate their cost-control and revenue-growth objectives. It's a challenging task, and one that calls for specific leadership skills. Ed Boswell, CEO of leadership consultancy The Forum Corp., outlines three critical skills that senior executives will need in order to drive a sustainable growth strategy:

Flexibility and agility. In a cost-cutting environment, executives and managers have a singular, fairly rigid focus on reducing expenditures. In a sustainable-growth environment, leaders must recognize unexpected opportunities and be flexible enough to take advantage of them. Top-performing companies equip their leaders with the agility required to retool their strategies as often and as quickly as necessary.

Effective communication. When an economic downturn stunts top-line growth, executives and managers have a simple, easily understood message to deliver: Keep costs down. But sustainable growth strategies are more complex and less easily understood. Senior leaders and managers must be able to communicate clearly with employees to help them understand and act.

Perspective. A company that's driven by cost cutting initiatives is, by nature, inwardly focused. Executives who succeed at implementing growth strategies are able to shift the perspective of other leaders and employees, turning it from an inward to an outward focus, from cost-cutting to revenue growth and from products to customers.